An Introduction to Receiverships

American state and federal courts have the equitable power to take custody of property at issue in a legal dispute and to appoint a receiver to act as agent for the court in keeping, managing, and even selling the property, in order to protect the interests of those parties with a claim on such property. The extent of a given receiver’s duties and powers depend upon the common law and statutes of the jurisdiction, the range of discretion of the judge, the powers delineated in the receiver’s appointment order, and the facts of the case.

What Are Receivers Used For?

The most common use of receivers in state court cases is upon the request of a mortgage lender that wants the real property collateral to be preserved (and rents collected for the benefit of the lender), often pending the resolution of a foreclosure action. State and federal court-appointed receivers may be called upon to manage and perhaps sell (as a going concern) or to liquidate and wind-down entire businesses. Federal equity receivers can be appointed at the request of, among other entities, federal agencies. For example, the Ponzi scheme prosecution of Thomas J. Petters in Minnesota was accompanied by a federal equity receivership over many of his business entities, intended to gather in and preserve assets from many jurisdictions for distribution to harmed parties and other creditors.

Thus a receiver may be “general,” with custody of all of a business entity, or “special” (also known as “limited”), with custody of one asset, such as commercial real property that is collateral for a loan on which the larger business entity has defaulted (there are also “pendante lite” and “statutory” receivers, but let us leave them for another day). Not every state authorizes the appointment of a general receiver. Most states authorize the appointment of receivers under varied circumstances.

On What Basis Are Receivers Appointed?

Factors for appointment in state courts, which may or may not be set out in a statute, often include one or more of the following: (a) valid claim by requesting party; (b) fraudulent conduct on part of owner of the property; (c) imminent danger that the property will be lost, concealed, wasted, or squandered; (d) inadequacy of legal remedies; (e) probability that harm of denial to requesting party outweighs the injury of appointment to opposed parties; (f) requesting party’s probable success in the action; and (g) possibility of irreparable harm to requesting party’s interest in the property. These factors also apply to federal receivership appointments.

Standards for appointment vary. A given court may appoint a receiver of commercial real property where it is shown that the borrower defaulted on the loan and the loan documents entitled the lender to a receiver upon default (e.g., Illinois). A court elsewhere may require proof that the borrower is insolvent and committing waste, and that the value of the mortgaged property is inadequate to cover the mortgaged debt (e.g., Minnesota). A receiver may be appointed even outside of a pending foreclosure action to collect rents or upon the borrower’s failure to pay taxes or insurance premiums (e.g., Michigan). Insolvency may not be required where the mortgage specifically assigns rents as security (e.g., Iowa). Also, burdens of proof vary from jurisdiction to jurisdiction.

Receivership by Consent?

Continuing with the borrower and mortgagor of commercial real property example, what is in the loan documents may be key to the possible extent of a receiver’s powers. Under such documents, mortgagors commonly consent to receiverships and may waive rights to redeem the property after the appointmet of a receiver. Some states will honor these consents, some will give such consents evidentiary weight but not conclusive evidentiary weight. A court may not enforce a consent to appointment of a receiver on default where the state law would not permit appointment upon that premise. Whether and under what conditions the various states will enforce redemption rights waivers is the subject of a recent drafting committee memorandum for a group working on a Model Act on Appointment and Powers of Real Estate Receivers.

Even if a receivership consent is enforceable, the loan documents may frustrate the effectiveness of a receivership where aspects of property necessary for managing the collateral or running the business are not included (or specified accurately) in the collateral. A lender may be well-advised to imagine a borrower’s future insolvency and craft a collateral package that will be adequate, upon the appointment of a receiver, to empower the receiver to do what’s necessary to preserve or realize value. Does running the business require access to software, parking rights, licenses, permits, or insurance? To the extent possible, necessary items should be collateral or otherwise be made effectively accessible by a future receiver.

The Receivership Appointment Order

This is all important. A receiver may do only what the court expressly permits it to do. For starters, a receivership order should: (1) explain the reason(s) for receivership; (2) describe receivership assets; (3) establish receiver’s right to custody of property and require the owner to deliver; (4) empower the receiver to borrow funds (and on what terms), enter into contracts, and to lease, sell, or dispose of assets (and on what terms); (5) empower the receiver to use owner’s permits and licenses and to apply for new permits and licenses; (5) authorize the receiver to pursue lawsuits on behalf of the receivership estate; (6) authorize receiver to employ professionals; (7) determine how the receiver is to be compensated; and (8) obligate the receiver to file reports with the court regarding the operations and finances of the receivership. It is not uncommon in a federal receivership for the receiver to be empowered to file a petition for bankruptcy protection for one or more of an owner’s business entities, as in the Petters Ponzi scheme example discussed above.

Sale of Receivership Estate Property

Returning to the borrower and mortgagor of commercial real property example, consider the secured creditor’s incentive to seek a receiver to manage and sell the commercial real property. Might the secured creditor thus evade the sometimes lengthy and expensive foreclosure process and just get a court to empower a receiver to sell? Would such a sale be free and clear of the mortgagor’s redemption rights? Can the proceeds of such a sale be maximized by making the sale free and clear of all liens and claims junior to those of the secured lender?

There is no uniformity across jurisdictions or circumstances to these questions. Here we punt to the following excellent sources, on which we relied in drafting this Introduction to receiverships (all errors herein are the author’s):

For more information about federal equity receivers, please go to www.nafer.org (NAFER is the National Association of Federal Equity Receivers). For further questions, please email the Executive Director of NAFER, Maureen Whalen, at Maureen.Whalen@nafer.org. Please also see “2015 NAFER Conference – Good, Better, BEST YET!”on this site.

Mr. Cahill is counsel with Lowis & Gellen LLP, in Chicago, Illinois. He guides secured lenders, creditors, debtors, creditors’ committees, potential purchasers and others through bankruptcy cases, out-of-court workouts, assignments for the benefit of creditors, and receiverships. Mr. Cahill has substantial mega-case experience at national law firms representing very large debtors, and has counseled and…